Wednesday, April 07, 2010

The Astonishing Voice of Albert Hirschman

Albert Hirschman is 95 years old today.

Four decades ago, he published Exit, Voice and Loyalty, a slim volume that contains more insights per page than just about anything else I have read. I consider it to be among the finest books ever written by an economist. For reasons discussed below, it also has enormous contemporary relevance.

The subtitle of the book is "Responses to Decline in Firms, Organizations and States." Hirschman's concern is with "repairable lapses" in organizational performance: declines that could be corrected with the right balance of information, incentives and flexibility of response. This is not a subject to which economists had paid much attention, and he begins by asking why:

While moralists and political scientists have been much concerned with rescuing individuals from immoral behavior, societies from corruption, and governments from decay, economists have paid little attention to repairable lapses of economic actors. There are two reasons for this neglect. First, in economics one assumes either fully and undeviatingly rational behavior, or, at the very least, an unchanging level of rationality... In other words, economists have typically assumed that a firm that falls behind... does so "for a good reason"; the concept... of a... "repairable lapse" has been alien to their reasoning.

The second cause of the economist's unconcern about lapses is related to the first. In the traditional model of the competitive economy, recovery from any lapse is not really essential. As one firm loses out in the struggle, its market share is taken up and its factors are hired by others... in the upshot, total resources may well be better allocated. With this picture in mind, the economist can afford to watch lapses of any one of his patients... with far greater equanimity than either the moralist who is convinced of the intrinsic worth of every one of his patients (individuals) or the political scientist whose patient (the state) is unique and irreplaceable.

But is the neglect justified? Hirschman argues that it is not, because the vision of a "relentlessly taut economy" operating at or close to its productive potential is inapplicable to technologically modern societies capable of producing a substantial surplus relative to the needs of subsistence. The very existence of the surplus implies that considerable slack in the level of efficiency can be tolerated without disastrous consequences. As a result, firms and other organizations are "permanently and randomly subject to decline and decay, that is, to a gradual loss of rationality, efficiency, and surplus-producing energy no matter how well the institutional framework within which they function is designed."

It is critically important, therefore to consider the "countervailing forces" that can arrest and reverse such decline. Hirschman identifies two such forces: desertion and articulation, or exit and voice. Exit refers to the fact that the customers of a firm (or members of an organization) can simply leave and attach themselves to a competing firm or organization. Voice refers to the expression of discontent: the natural human tendency to complain, protest, and generally "kick up a fuss." Each of these mechanisms is interesting in its own right, but it is the interaction of the two (and their connection to loyalty) that gives rise to the most intriguing possibilities.

One of Hirschman's key insights is that exit will not serve as a reliable recuperation mechanism if it occurs too rapidly in the face of organizational decline:

For competition (exit) to work as a mechanism of recuperation from performance lapses, it is generally best for a firm to have a mixture of alert and inert customers. The alert customers provide the firm with a feedback mechanism which starts the effort at recuperation while the inert customers provide it with the time and dollar cushion needed for this effort to come to fruition.

In addition, rapid rates of exit can deprive an organization of precisely those customers (or members) who, had they remained, would be most inclined to utilize voice:

[Those] customers who care most about the quality of the product and who, therefore, are those who would be the most active, reliable, and creative agents of voice are for that very reason also those who are apparently likely to exit first in case of deterioration.

As a result, the "rapid exit of the highly quality conscious customers... paralyzes voice by depriving it of its principal agents."

While it is commonly believed that most organizations would prefer that their customers or members had no exit option at all (as in the case of a monopoly) Hirschman argues, instead, that monopolists would welcome a modest degree of competition in order to shed their most vociferous customers:

[There] are many... cases where competition does not restrain monopoly as it is supposed to, but comforts and bolsters it by unburdening it of its more troublesome customers. As a result, one can define an important and too little noticed type of monopoly-tyranny: a limited type, an oppression of the weak by the incompetent and an exploitation of the poor by the lazy which is the more durable and stifling as it is both unambitious and escapable.

This is why those holding power in dysfunctional states "have long encouraged their political enemies and potential critics to remove themselves from the scene through voluntary exile."

More generally, the performance of near-monopolistic service providers may be worse than that which would prevail if monopoly power were absolute. This has enormous and wide-ranging implications. The poor performance of a national railway system might persist indefinitely if the most demanding customers also have recourse to road transportation. Public schools might deliver worse learning outcomes if private or parochial options are available to the most quality conscious parents. A small decline in neighborhood quality could turn into a precipitous collapse if those most affected by it simply move elsewhere. And the ease with which common stock can be sold implies that the most vigilant shareholders will liquidate their holdings rather than attempt to improve the performance of management.

While most environments are such that either exit or voice is the dominant response to decline, there is one arena, that of political competition, in which both mechanisms are critical. In this setting, taking account of voice leads to sharply different predictions than theories based only on exit. Hirschman's critique of the Hotelling-Downs analysis of political competition (and the median voter theorem it implies) is devastating:

As soon as the Hotelling model had been thus refurbished by Downs, its power to explain reality was again cast into doubt by the undisciplined vagaries of history. The selection by the Republican party of Goldwater in 1964... testified to the extreme reluctance of at least one party to conform to the Hotelling-Downs scenario...

[It was not] Hotelling's original assumption of inelastic demand... that was wrong or unrealistic, but the inference that the "captive" consumer (or voter) who has "nowhere else to go" is the epitome of powerlessness. True, he cannot exit... but just because of that he... will be maximally motivated to bring all sorts of potential influence into play so as to keep... the party from doing things that are highly obnoxious to him... in a two-party system a party will not necessarily behave as the Hotelling-Downs vote-maximizer because "those who have nowhere else to go" are not powerless but influential.

With modern communication technologies able to transmit, coordinate and amplify voice to an unprecedented degree, these insights have more relevance than ever.

As Hirschman's title suggests, the interplay between exit and voice depends critically on the presence or absence of loyalty:

By making exit less appealing, loyalty to an organization can therefore be functional; it can "neutralize within certain limits the tendency of the most quality conscious customers or members to be the first to exit." But since "the effectiveness of the voice mechanism is strengthened by the possibility of exit," too much loyalty will stifle voice. In particular, the active promotion of loyalty by an organization can be detrimental to its own long run functioning:

[Loyalty] promoting institutions and devices are not only uninterested in stimulating voice at the expense of exit: indeed they are often meant to repress voice alongside exit. While feedback through exit or voice is in the long-run interest of organization managers, their short run interest is to entrench themselves and to enhance their freedom to act as they wish, unmolested as far as possible by either desertions or complaints of members.

From this perspective, a key determinant of organizational performance is the price of exit (which may or may not arise from loyalty):

Such a price can range from loss of life-long associations to loss of life, with such intermediate penalties as excommunication, defamation, and deprivation of livelihood. Organizations able to extract these high penalties for exit are the most traditional human groups, such as the family, the tribe, the religious community, and the nation, as well as such more modern inventions as the gang and the totalitarian party... Since the high price of exit does away... with the threat of exit as an effective instrument of voice, these organizations... will often be able to repress both voice and exit. In the process, they will largely deprive themselves of both recuperation mechanisms.

And the absence of recuperation mechanisms can have catastrophic consequences, as the current predicament of the Roman Catholic Church vividly illustrates.

I could go on, but the point has been made. This is a book with dozens of sparking insights tied together by a coherent vision. The vision allows for a broad range of human motivation, encompassing (but not limited to) standard hypotheses regarding rational behavior. Economic actors in Hirschman's world shop for lower prices and higher quality, to be sure, but they also capable of making a nuisance of themselves, engaging in self-deception, and displaying fierce loyalty to organizations with which they are affiliated. This rich, complex conception of human behavior allows for a sweeping analysis that is as penetrating as it is ambitious.

My birthday wish for Albert Hirschman today is nothing less than that which he has long deserved: the Nobel Memorial Prize in Economics.